Tapping into the fixed-interest seam can be profitable

Published on 12/12/2008 18:33

THERE is a growing consensus that investment grade corporate bonds currently offer good value.

These bonds approach the quality of government bonds, but historically pay a modest interest rate to compensate investors for the additional risks of lending to a company rather than to a government. This spread between government and corporate bonds is at a historic high.

The relative appeal of government bonds in relation to corporate bonds, whether investment grade or their riskier high-yield counterparts, varies according to where we are in the economic cycle.

Very few fixed-interest funds thrive in all conditions. but the M&G Optimal Income fund seeks to tap into the richest seam from the varied world of fixed-interest securities.

The fund's mandate allows manager Richard Woolnough to allocate money across the spectrum of highest to lowest quality debt.

"You need to be able to look across the whole gamut," said Woolnough. "One man can't do this on his own. You need a team of specialists covering all sectors from government bonds to high-yield corporates. We have a dedicated and growing team of credit specialists to help with this task."

The fund has a total return objective, meaning that it has no specific income target to meet. With the price of many bonds having fallen significantly, some household names are currently offering hugely attractive yields to maturity. For example, an M&S bond with a coupon of 5.875 per cent maturing in 2012 is currently offering a 10.4 per cent return.

Rather than being able to pick all the winners, one of the most important tasks for any bond manager is to avoid the losers at all costs. These are companies who will lose their investment grade status or default on their obligations.

"Ask yourself a simple question. Can I postpone purchasing those goods or services? If the answer is yes, such as housing and autos, then companies in these sectors are the ones most likely to suffer," said Woolnough. "For consumer staples such as food, or even alcohol these days, there is less risk."

The current recession will inevitably lead to defaults on some bonds. Woolnough is keen that the authorities provide the right type of support to businesses which in more normal times would come through a downturn leaner but still intact. "Companies will inevitably go to the wall in the current climate, but some pastoral care is required to ensure we don't lose good businesses."

&#149 For more information on the M&G Optimal Income fund, call M&G on 0800 390 390.

Barry O'Neill is a chartered financial planner and director with Thomson Shepherd Limited (incorporating Coggans Wood).